Start Saving or Get Ready for U.S. Decline: Laurence Kotlikoff

America has a terrible saving
problem and a slumping economy. But our national mantra,
underscored by last week’s payroll-tax cut, is spend, spend,
spend.

Yet, countries can’t spend their way to prosperity. This
demand-side voodoo-economics approach is driving us further
into hock. The right mantra should be save, save, save.

Consider a bifurcated economy. In one part, workers are
fully employed, producing and getting paid 1,000 kernels of
corn, which can be consumed or saved. Workers are allergic to
the corn that their company produces. So they make one type of
corn, get paid, and buy different corn from other companies.

If the workers collectively consume, say, 600 kernels now
and save 400, they will have produced 600 of consumption goods
and 400 of investment goods. If they consume, say, 800 kernels,
800 will have been produced for consumption and only 200 for
saving or investment. Having the workers consume more changes
the consumption-investment production mix, but it doesn’t
increase gross domestic product or employment.

Moreover, regardless of how much the workers spend, the
unemployed in the economy’s other part are still miserable. In
that part, which produces and consumes only beans, firms aren’t
hiring because they think no one else is doing so and that they
won’t be able to sell the beans they produce. This failure
requires coordinated hiring, not having the employed overspend
and underprovide for retirement.

Winning Votes

That brings us to last week’s extension of the payroll-tax
cut, which is supposed to increase spending by workers. Never
mind that the real reason the two political parties reached the
deal was to secure the votes of those already working. As for
the unemployed, it’s “Sorry, no job, no taxes, no tax cut.”

Facts reinforce the idea that spending is no cure-all for
what ails America. Most countries experiencing full employment
and rapid growth do so while saving at very high rates. China (CNGDPYOY) is
growing like crazy with a saving rate of more than 30 percent.
Japan also saved at very high rates when it was booming. Since
then, both rates have plummeted.

The U.S. has also done better when saving was high. In the
1950s and 1960s, saving averaged 14 percent of national income,
which grew at 4.4 percent a year in real terms. In the 1990s and
2000s, saving averaged 5.1 percent and national income increased
only 2.4 percent.

The connection between saving and growth runs through
domestic investment. Countries that save invest not only by
building inventory for tomorrow; they also invest in physical
capital that makes workers more productive.

U.S. saving is highly correlated with domestic investment;
when we save, we primarily invest here at home in starting
businesses, buying equipment, and building factories.

Yes, causation can reverse and run from growth to saving.
When recessions hit, national income falls by more than
consumption as households try to maintain their living
standards. Hence, lower growth coincides with lower saving.

But slumps can’t explain our secular decline in saving and
investment. We’ve been spending larger shares of national income
in good and bad times.

Our country is now saving nothing and, consequently,
investing next to nothing and growing slowly. Last year’s net
national saving rate was 0.1 percent. In 2009, it was negative
1.7 percent. This year, we’ll be lucky to hit 0.5 percent. You
have to go back to the 1930s to find saving rates this low.

Our net domestic investment rate in 2009 was a measly 2.1
percent. Last year, it was a paltry 4.4 percent, and this year
it may reach 5 percent. These, too, are historic lows.

What explains the saving decline? It’s not government
consumption, whose share of national income was slightly smaller
in the last decade than in mid-century. It’s households.

Household Spending

In the ‘50s and ‘60s, households spent, on average, 83
percent of each year’s available national income after
government consumption. In the 1970s, this household spending
rate rose to 86 percent and kept rising, reaching almost 96 in
the past decade. In 2009, the rate was 102 percent (we spent
down assets), and last year, after the recession formally ended,
it was about 100 percent.

Which households are responsible for all the extra
spending?

Older households are the big spenders, economists
Ronald Lee and Andrew Mason wrote in their book
“Population Aging and the Generational Economy,” published in
August. In 1960, the average consumption expenditure of people
in their 70s was 86 percent of the amount for people in their
30s. In 1981, it was 114 percent. By 2007, the rate was up to
144 percent.

This pattern shows up in other ways. In 1960, those over
age 60 accounted for 13 percent of the population and 14 percent
of household consumption. By 2007, they accounted for 17 percent
of the population, but 24 percent of total consumption. So their
population share rose by 31 percent, while their consumption
share rose by 71 percent.

How come? Because of transfer programs. In 1960, Medicare
and Medicaid didn’t exist and Social Security benefits per
oldster were small. Today, these benefits per oldster total 72
percent of per-capita GDP and will reach roughly 85 percent in
20 years when all 78 million baby boomers are fully retired. We
will be lucky if our national saving rate remains at zero.

The bottom line is, we’re taking from young savers and
giving to old spenders. We need to reverse course and raise
national saving and, thus, domestic investment with
generationally fair policies. The alternative is an early
economic grave.

(Laurence Kotlikoff, a professor of economics at Boston
University, is a Bloomberg View columnist. The opinions
expressed are his own.)

To contact the writer of this article:
Laurence Kotlikoff at kotlikoff@gmail.com